PCTY - Paylocity: Strong Guidance Sets It Up For Big Move Either Way

Summary

• Since mid-August, the share price of the company has been getting hammered.
• It appears the market isn't convinced of the strong guidance given in the last earnings report of PCTY.
• The assumptions of the company are it doesn't see a big downturn coming and will operate as it has in the past under economic slowdowns.
• What happens next will be determined by whether or not the company meets guidance.

In its last earnings report Paylocity Holding Corporation ( PCTY ) provided surprisingly strong guidance, which apparently the market didn't embrace well, as its share price has been getting hammered since mid-August, even with a couple straight quarters of beating the top and bottom lines.

With positive outcomes and strong guidance, it appears the market is pricing in a potentially deep recession which would have a significant impact on the performance of PCTY if that's how it plays out.

Since August 5, 2022, when the company hit its 52-week high or $276.88, it has since pulled back to trade at a 52-week low of $152.01 on January 6, 2023. At this time it's trading slightly above that recent low.

My thought at this time is the market may enter into a holding period on the stock until its next earnings report or macro-economic points to a deepening recession that would have an impact on hiring and employee retention in the quarters ahead.

Management doesn't think the recession will go deeper, and determined its guidance based upon that assumption.

In this article we'll look at some of its recent numbers, the macro-economic situation, and how the company plans on responding to economic conditions going forward, based upon its past experiences.

Recent numbers

Revenue in the first fiscal quarter of 2023 was $253.3 million, up 39.4 percent from $181.7 million in revenue generated in the first fiscal quarter of 2022, beating its prior guidance by $12 million.

Gross profit in the quarter was $84.5 million, up approximately $21 million from gross profit of $63.2 million in the same quarter last year. Adjusted gross profit in the reporting period was 72.1 percent, up from adjusted gross profit of $70.5 percent year-over-year.

Sales and marketing expenses in the first fiscal quarter of 2023 were $71 million, or 23.9 percent of revenue on a non-GAAP basis in the reporting period, up from $50 million in sales and marketing expenses last year in the same quarter. R&D expenses were $40.1 million, up 44.9 percent from $23.1 million in the first fiscal quarter of 2022.

The company stated that R&D spend for fiscal 2023 will be incremental and used to "build out the Paylocity platform."

Adjusted EBITDA in the quarter was $66.6 million, beating guidance by $8.6 million. Adjusted EBITDA margin was 26.3 percent.

Net income in the reporting period was $30.4 million or $0.54 per diluted share, compared to net income of $30.9 million or $0.55 per diluted share in the first fiscal quarter of 2022.

Cash and cash equivalents at the end of the first fiscal quarter of 2023 was $65.5 million, compared to cash and cash equivalents of $140 million at the end of the first fiscal quarter of 2022, The company had no debt at the end of the reporting period.

Guidance in the second fiscal quarter of 2023 was for revenue to be in a range of $257 million to $261 million, up approximately 32 percent year-over-year, and adjusted EBITDA to be in a range of $63.5 million to $66.5 million, slightly down from the first fiscal quarter of 2023.

Full-year guidance for fiscal 2023 is for revenue to be in a range of $1.22 billion to $1.127 billion, up about 32 percent from full-year 2022. Adjusted EBITDA for fiscal 2023 is for it to be in a range of $336 million to $340 million.

As mentioned earlier, guidance is based upon the assumption there won't be a deep recession in 2023. While that's definitely a possibility, my major problem with guiding for full-year 2023 is doing it in the first place because I don't see how anybody in the current environment can confidently point to its full-year performance under economic conditions that lack clarity at this time.

How management views a potential downturn

When asked about how the company factored in a potential economic downturn in 2023, the response was , "We did not assume a degradation going forward." At the same time management did acknowledge that after some growth in July and October of 2022, it did start to see things normalize afterwards. It took the normalization into account, but not a severe economic downturn when offering its guidance for 2023.

Management said, "it would take a pretty significant downturn from a macro standpoint to materially impact our revenue results."

As for responding to any level of economic downturn, the company cited the pandemic as a "guidepost" for how it's likely to respond if the economy weakens in any meaningful way in 2023.

Under those conditions the company is determined to continue to run the business consistently, meaning it'll continue to invest in R&D and S&M, while hiring across the business. The point being made there is that the company will continue to invest for future growth even if there are temporary headwinds beyond the level where they think they'll be in 2023.

The company is confident in the momentum it sales team has triggered, and believes it'll continue to boost revenue while retaining customers. With that in mind, it doesn't see any near-term risks that will have a negative impact on the performance of the company.

Labor market

There is a lot of news coming out concerning layoffs and terminations, and if that hits PCTY's customer base in any significant way, it'll have an impact on its performance, which I think is what has put the strong, downward pressure on its share price since August.

Looking at the company's chart, it began the big runup in the middle of June 2022 before reaching its aforementioned 52-week high in August 2022. That may have been from the anticipation of seasonal hiring during the Christmas and/or holiday season, and after that investors took profits with everything related to that already being priced in.

Since the company gets paid on a per employee per month basis, the retention of employees is a big part of the company's revenue, and if that metric starts to suffer, the stock will suffer with it. Again, I think that's the major negative catalyst driving the share price of the company down over the last several months.

Conclusion

The company has come off of a couple of good quarters, beating on the top and bottom lines during that time, and believes it still has momentum going as it calendar 2023 starts.

Based upon its positive guidance and the assumptions it made with it, it's possible it has set itself up for failure if it misses in any big way in the quarters ahead. I think it was premature to offer full-year guidance because of the lack of clarity concerning macro-economic conditions in calendar 2023.

My sense right now is the company may be far too optimistic on the economy over the next year, and basing guidance on a soft landing at worse, while gutsy, could easily result in the stock getting hit much harder than it has over the last several months if it fails to execute.

As mentioned in the title of the article, guidance has set the company up for a big move, the question is in which direction that move is going to take. My thesis is it's going to be to the downside because the economy is probably going to weaken deeper than PCTY thinks, and if that's accurate, the positive guidance is going to come back and bite them hard.

On the other hand, if management is correct in its assessment of the economy, it would result in a nice move to the upside.

Having said all that, we do have the strategy of the company under any scenario in 2023, and that is to continue spending on R&D and sales and management in order to prepare for future growth if the economic conditions are better or worse than expected.

That would help shareholders in the near term if the share price further collapses, but it will provide a blueprint for how it's going to work its way out of the challenging times if that's how it plays out in 2023.

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